CONTRACTUAL CONTINGENCIES AND RENEGOTIATION

In a dynamic model of asymmetric information between the owner of a fi rm and a manager, we investigate the optimal set of contingencies on w hich an incentive contract should depend when renegotiation is possibl e. In particular, we characterize the circumstances in which the contr acting parties find it desirable to deliberately restrict what the own er can monitor, thereby limiting the contractible contingencies. Our f indings thus provide an endogenous explanation for contract simplicity , in contrast to those based on transactions costs or bounded rational ity.